In response to a short piece on inequality that I wrote in German, a reader sent me the editorial of Der Spiegel of this week. As by miracle, the editorial also deals with inequality. I had already suspected that the editors of the most important German media had made phone calls. The article fully confirms what I suspected.

The whole argument runs along the following lines: policy-makers desired higher inequality, because it was necessary for their unemployment program. This program has been incredibly ‘successful:’ it created millions of new jobs, but, since wages are so low, we now have to smear some thick white ointment on people’s wounds because otherwise they will not buy the whole story. Or, literally in Der Spiegel: ‘The Hartz reforms were adequate instruments. The reforms created millions of new jobs for the unemployed. Now the question remains how to transform as many of these ‘mini jobs’ and low quality jobs into regular employment that pays more than the minimum wage.’

Then follows the reasoning that is often used to misinform uninformed people. I quote again from Der Spiegel: ‘Because the rich put a greater proportion of their income away for a rainy day, the economy can get out of balance when income growth is too much concentrated in high income earners. When this happens, too much saving is taking place within the economy. As a consequence, there is less investment, the manufacturers of consumer goods begin to suffer and too much capital flows abroad, because there are insufficient lucrative investment opportunities within the country. Many experts are convinced that this is the reason why the German economy slowed down for many years. Consumption only grew by half as much as the national product in the first decade of the new century.’

Isn’t this pure genius? It sounds incredibly obvious, doesn’t it? If only we had less income inequality, there would be more growth and more jobs. The empirical evidence clearly shows that the propensity to save in lower income groups is less than in higher income brackets: one monetary unit earned by someone from the middle class more is spend faster than the same monetary unit earned by someone of the higher income group.  So, is the problem then that we save too much and that there is too little demand? Or does the real problem lie somewhere else?

If you think about this for a moment, you will begin to doubt all of it. Why does Der Spiegel only refer to the different savings rates of the income groups when they address inequalities between the poor and the rich? Should they not also deal with the income development as such of both groups? That at a given income structure, consumer demand is bigger if the income distribution is more in favour of the income groups with the higher propensity to consume (and the lower savings rate) is indeed not difficult to understand, it is plain and simple common sense.

Any neoclassical economist will disagree with the notion that redistribution of income can happen at the expense of companies. The reason is that any redistribution away from wages and towards profits would positively impact the rate of investment. The other way round, rising wages would hurt investment. Investment – so goes their argument – is also a component of aggregate demand, which means that such a redistribution at the expense of profits would be harmful to the economy in the medium to long-term because it deters investors. No one really wins in such a situation: new jobs would not be sustainable, consumer demand would only rise short term and it is even possible that the policy does more harm than good in the longer term because of the possible loss of confidence among investors.

The crucial mistake of the reasoning in Der Spiegel is that it fails to explain how the imbalance in income growth came about. Those who do not look for the cause of a problem cannot find a solution for it. Here the weakness of the argument of the entire ruling doctrine on inequality comes to light: although since 2008-2009 income inequality continuously increased, the average savings rate, by any means, did not rise (it was not the case in the US, nor, for example, did it happen in Germany). But this is, of course, what should have happened if the fundamental cause of weak growth and the instability of the market economy at large has to do with different saving rates for different income groups. Such an explanation leads to the conclusion that one must try to overcome the weakness in growth by making higher income groups spend more and save less.

But if this is not correct, if the disproportionate saving rates of the income groups do not explain low growth, then what causes sluggish growth? It is the evolution of income itself! The income of workers did not increase for many years, because some believed that (exactly as Der Spiegel suggests), it was possible to solve the unemployment conundrum by decoupling workers’ incomes from productivity growth.

The skewed distribution of income is a direct consequence of high unemployment and the failed neoclassical ways to combat it. On the one hand, income falls immediately for those who become unemployed, because social welfare payments are significantly lower than their previous wage. On the other hand, those who remain in employment suffer too. Their wages stagnate because of the shift of power in labour markets and because of the policies of the Schröder government substantially weakened the position of workers in collective bargaining.

It is clear that such weakness hits lower income groups harder than other income groups. The threat of losing one’s job is strongest for the least qualified, while, once unemployed, they need to deal with more competition on the labour market than others. This puts further pressure on their already meagre wages. All of this is well-known. It is absolutely no coincidence that a poor overall wage growth leads to increasing inequality within the group of workers. Indeed, it is perfectly logical.

This is therefore a very different story: increasing inequality within the group of wage earners is not the fundamental cause of sluggish growth, but its result. And the increasing inequality between those who get their income from capital and those who get their income from employment is a result of the shifting balance of power in labour markets. That inequality, in turn, helps to cement poor macroeconomic performance is certainly true, but it is not the core of the problem.

Why does Der Spiegel not (or at least not also) mention falling or only slightly rising incomes of employees in total? Only real wage stagnation, not the savings rates, explains why consumer demand has not increased during the first decade after the turn of the century. Workers’ real income has risen by much less than what would have been possible on the basis of the average productivity growth. The representatives of the ruling doctrine prefer of course not to talk about wage stagnation, because they remain firmly convinced that exactly this has created millions of jobs.   If we apply the argument of the disproportionate savings rate to the euro crisis, one can see immediately how wrong it is: in southern Europe, demand plummeted in the last two years and many jobs have been lost. During the same period, workers’ wages were greatly reduced in absolute terms. Sank demand primarily because income distribution changed in favour of the rich? Was it not the case, then, that incomes decreased in general and that the people who were affected had less to consume, even if this did not change their savings rate or the savings rate of the economy as a whole? Or to put this in yet another way: even if the distribution of income would have changed in favour of the poor during the crisis or if their savings rate would have fallen (which may even have been the case), it would nonetheless not have led to a huge absolute shortfall in demand that we witnessed, although it would perhaps have fallen by a little less.

The crucial weakness of the prevailing doctrine has become evident here. The way in which the labour market functions and the results that it creates must never be questioned. To neoclassical economists, all theory about it is superfluous: the labour market is just like any other market, say a potato market. Because you are not allowed to question the dogma, one prefers to occupy oneself with question of who saves how much from her or his wage (the level of which remains unquestioned as it is seen as a result of supply and demand) and how much demand such saving withdraws from the economic cycle. Consequently, nothing ever goes any further than timid calls for slight corrections of seemingly objective income results of the labour market. Perhaps government can intervene, but just a bit. Perhaps a little bit more education is warranted. Perhaps, a very slight wealth tax can be introduced. These are the limits. Then all is well.

Of course, the labour market does not work like the potato market. As we have seen in 2008-2009, labour markets lead to absolutely incorrect and unacceptable outcomes. At that time, unemployment rose, although wages were not high, they were low. Only those who take notice of real world phenomena and draw logical conclusions are really capable of making a contribution to a new understanding of economic processes. Only those are able to formulate useful economic policy advice. Everything else is window dressing and white ointment for wounds that risk to never heal.